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CVP

ANALYSIS
COST VOLUME PROFIT ANALYSIS
COST VOLUME PROFIT ANALYSIS (CVP)

CVP analysis can be used to calculate the sales


volume necessary to achieve a target profit, stated
as either a fixed or variable amount on a before- or
after-tax basis.
Sales price per
unit is constant.
Variable costs Total fixed
per unit are costs are
constant. constant.
COST
VOLUME
PROFIT Costs are only
Everything affected
produced is because
sold. If a company activity
sells more than changes.
one product,
they are sold in
the same mix.
COST VOLUME PROFIT ANALYSIS (CVP)

sales revenue
CONTRIBUTION
MARGIN
minus all
variable costs

The contribution
CONTRIBUTION
margin is divided
MARGIN
by the sales or
RATIO
revenues amount
COST VOLUME PROFIT ANALYSIS (CVP)

Managers use CVP analysis to effectively plan and


control by concentrating on the relationships among
revenues, cost, volume changes, taxes, and profit.
The CVP model can be expressed mathematically or
graphically. The CVP model considers all costs,
regardless of whether they are product, period, variable,
or fixed. The analysis is usually performed on a
companywide basis.
COST VOLUME PROFIT ANALYSIS (CVP)
• Is one of the most hallowed, and yet one of the simplest, analytical
tools in management accounting.
• Allows managers to examine the possible impacts of a wide range of
strategic decisions in such crucial areas as pricing, policies, product
mixes, market expansions or contractions, outsourcing contracts, idle
plant usage, discretionary expense planning, and a variety of other
important considerations in the planning process.
• Allows also the managers to set a desired target profit and focus on
the relationships between it and other known income statement
amounts to find an unknown.
COST VOLUME PROFIT ANALYSIS (CVP)
• Sales volume is needed to generate a particular profit amount
• Selling price is generally not as commonly unknown as volume
• • A product's selling price is often market-related rather than being a
management decision variable.
• • Managers can use CVP to determine how high variable cost can be while
allowing the company to produce a desired amount of profit.
• Variable cost can be affected by modifying product specifications or
material quality as well as by being more efficient or effective in the
production, service, and/or distribution processes.
COST VOLUME PROFIT ANALYSIS (CVP)

Fixed Amount of Profit

Specific Amount of
Profit Per Unit
Fixed Amount
of Profit
Fixed Amount of Profit
• Contribution margin represents the sales remaining
after variable cost is covered.

• Before Tax
• After Tax
Fixed Amount of Profit: BEFORE TAX
 Before Tax Profit can be treated in the break-even formula as an
additional cost to be covered. Inclusion of a target profit changes the
break-even formula to a CVP equation. C
CVP Formula for Fixed Before Tax Profit :

Where In:
R(X) - VC(X) - FC = PBT R = revenue (selling price) per unit
X =volume (number of units)
R(X) - VC(X) = FC + PBT R(X) =total revenue
VC =variable cost per unit
VC(X) = total variable cost
X = (FC + PBT) ÷ (R - VC) FC = total fixed cost
P = total profit
X = (FC + PBT) ÷ CM
Fixed Amount of Profit: AFTER TAX
• In choosing a target profit amount, managers must recognize
that income tax represents a significant influence on business
decision making.

• A company wanting a particular amount of profit after tax


must first determine, given the applicable tax rate, the amount
of profit that must be earned on a before-tax basis.
Fixed Amount of Profit: AFTER TAX
CVP Formula for Fixed After Tax Profit:
PBT - [(TR)(PBT)] = PAT
R(X) - VC(X) - FC - [(TR)(PBT)] = PAT

Where:
PBT =fixed amount of profit before tax
PAT = fixed amount of profit after tax
TR = tax rate
Fixed Amount of Profit: AFTER TAX
CVP Formula for Fixed After Tax Profit:
PBT - [(TR)(PBT)] = PAT
R(X) - VC(X) - FC - [(TR)(PBT)] = PAT

Where:
PBT =fixed amount of profit before tax
PAT = fixed amount of profit after tax
TR = tax rate
Fixed Amount of Profit: AFTER TAX
CVP Formula for Fixed After Tax Profit:
PBT - [(TR)(PBT)] = PAT
R(X) - VC(X) - FC - [(TR)(PBT)] = PAT

Where:
PBT =fixed amount of profit before tax
PAT = fixed amount of profit after tax
TR = tax rate
Fixed Amount of Profit: AFTER TAX
PAT is further defined so that it can be integrated into the original CVP formula:
PBT (1 - TR) = PAT or PBT= PAT ÷ (1 - TR)
Substituting into the formula,

R(X) - VC(X) - FC = PBT

R(X) - VC(X) = FC + PBT

(R - VC)(X) = FC + [PAT ÷ (1 - TR)]

CM(X)= FC + [PAT ÷ (1 - TR)]


Fixed Amount of Profit: PROBLEM
Fixed Amount of Profit: PROBLEM
Fixed Amount of Profit: ANSWER
A. If Sheridan Shacks wants to earn an after-tax profit of $182,000, how many garden
sheds must it sell?

$182,000 ÷ (1− 0.35) = $280,000


($260,000 + $280,000) ÷ $800 = 675 garden sheds.
Fixed Amount of Profit: ANSWER
B. How much revenue is needed to yield an after-tax profit of 8 percent of revenue? How
many garden sheds does this revenue amount represent?
Let R = revenue; then 0.08R = After-tax income desired

Before-tax income = 0.08R ÷ (1 – 0.35) = 0.123R

$1,800X − $1,000X − $260,000 = 0.123($1,800)X

$800X − $260,000 = $221.4X

$578.6X = $260,000

X = 450 units (rounded) sold to earn 8 percent of revenue after tax

Amount of revenue = 450 × $1,800 = $810,000


Specific
Amount Profit
Per Unit
Specific Amount Profit Per Unit

Managers may want to conduct an analysis of profit


on a per-unit basis. For these alternatives, the CVP
formula must be adjusted to recognize that profit is
related to volume of activity.
Specific Amount Profit Per Unit: BEFORE TAX

o The adjusted CVP formula for computing the necessary unit


sales volume to earn a specified amount of profit before tax
per unit is :
R(X) - VC(X) - FC = PuBT(X)

where PuBT = amount of profit per unit before tax


Specific Amount Profit Per Unit: BEFORE TAX

o Solving for X (volume) gives the following:


Where In:
R(X) – VC(X) – PuBT(X)=FC R = revenue (selling price) per unit
CM(X) – PuBT(X) = FC X =volume (number of units)
R(X) =total revenue
X= FC/(CM-PuBT) VC =variable cost per unit
VC(X) = total variable cost
FC = total fixed cost
P = total profit
Specific Amount Profit Per Unit: BEFORE TAX
 This treatment effectively “adjusts” the original contribution margin and
contribution margin ratio.

When setting the desired profit as a percentage of selling price, the profit
percentage cannot exceed the contribution margin ratio. If it does, an
infeasible problem is created because the “adjusted” contribution margin
is negative.

In such a case, the variable cost ratio plus the desired profit percentage
would exceed 100 percent of the selling price, and such a condition cannot
exist.
Specific Amount Profit Per Unit: BEFORE TAX
 Assume that Sesame’s president wants to know what level of sales (in clocks and
dollars) would be required to earn a 15 percent before-tax profit on sales. This rate of
return translates into a set amount of profit per unit of $6.
Specific Amount Profit Per Unit: AFTER TAX
oAdjusting the CVP formula to determine unit profit on an after-tax basis
involves stating profit in relation to both the volume and the tax rate.

R(X) - VC(X) - FC - {(TR)[PuBT(X)]} = PuAT(X)

where PuAT = amount of profit per unit after tax


Specific Amount Profit Per Unit: AFTER TAX
oPuAT is further defined so that it can be integrated into the original
CVP formula:
PuAT(X) = PuBT(X) - {(TR)[PuBT(X)]}
PuAT(X)= PuBT(X)[(1-TR)]
PuBT(X) = [PuAT / (1-TR)](X)

Where:
PuAT – Profit per unit After Tax
PuBT – Profit per unit Before Tax
TR – Tax Rate
Specific Amount Profit Per Unit: AFTER TAX
oThus, the following relationship exists:

R(X) – VC(X) = FC + [PuAT/(1 – TR)](X)


CM(X) = FC + PuBT (X)
CM(X) – PuBT (X) = FC
Where In:
X = FC / (CM – PuBT) R = revenue (selling price) per unit
X =volume (number of units)
R(X) =total revenue
VC =variable cost per unit
VC(X) = total variable cost
FC = total fixed cost
P = total profit
Specific Amount Profit Per Unit: AFTER TAX
Sesame’s managers want to earn an after-tax profit of 10 percent
of revenue and the company has a 25 percent tax rate.
Specific Amount Profit Per Unit: PROBLEM
Specific Amount Profit Per Unit: ANSWER
A. How many golf carts must Golf Glider sell to earn $600,000 after tax?

$600,000 ÷ (1 − 0.40) = $1,000,000

$5,000P − $3,000P − $370,000 = $1,000,000


$2,000P = $1,370,000
= 685 golf carts

total variable costs per unit = $3,000


total fixed costs = $370,000.
pre-tax income= $1,000,000
Specific Amount Profit Per Unit: ANSWER
B. What level of revenue is needed to yield an after-tax income equal to
20 percent of sales?
after-tax equivalent
20% ÷ (1 − 0.40) = 33.33%
Variable costs as a percentage
of sales
$3,000 ÷ $5,000 = 60%
R – 0.6R – $370,000 = 0.3333R
0.0667R = $370,000
R = $5,547,226
COST PROFIT ANALYSIS (CVP)
 Determine BEP by assigning a zero value to the profit figure.

 Study the interrelationships of


oprices
ovolumes
ofixed and variable costs
ocontribution margins
 Calculate the level of sales volume necessary to achieve specific before- or
after-tax target profit objectives.
 Enhance a manager’s ability to positively
influence current operations and to
predict future operations, thereby reducing the risk of uncertainty.